Though mutual fund wrap programs are extremely popular with the investing public, we feel they simply add a layer of fees that you don’t need and can damage your investment results over time. Far better to do a little extra work and make sure your fund portfolio is right for you.

Fund wraps, or all-in-one mutual fund advisory programs, have become increasingly popular among small investors over the years. But we think wrap programs are useful only for investors who want nothing to do with managing their portfolios — and are willing to pay for the most basic of services.

Fund wrap programs offer a number of portfolios containing a number of mutual funds. Each portfolio is designed to reflect a pre-selected asset allocation model that meets the needs of a particular type of investor.

The concept is similar to a balanced fund, which typically provides you with direct exposure to different types of assets, most notably cash, fixed-income securities and equities. In the case of a wrap program, however, portfolio management within the different asset categories is generally outsourced to a number of different managers. But decisions about the overall asset allocation remain the responsibility of the wrap sponsor.

Two types of wraps: Fund wraps are either “fund of funds” or “portfolio allocation services”. In the former, you own units of a pool of mutual funds. In the latter, you own units of a number of mutual funds directly in proportions determined by the allocation service.

The fund-of-funds model is quite common. Fund companies may refer to these wraps as “portfolio solutions”, or perhaps “select portfolios”. For convenience, their fees are combined into one overall wrap fee.

The problem is you essentially pay fees for the underlying products of the wrap, and then more fees for the allocation services. Taken together, these fees tend to be higher than those you would otherwise pay if you held the same funds in the same proportions outside a wrap. Indeed, fees can be higher by as much as half a percentage point with a wrap. That may not sound like much. But as we point out below, fees can put quite a dent in your returns over time, so minimizing them is a good idea.

Given the similarity between wrap programs and balanced funds, it should come as no surprise to long-time readers of this publication that we don’t favour wraps. Much like investing in a balanced fund, wraps don’t give you the type of careful control you get when you make a personalized asset-allocation decision and invest directly in equity funds or stocks along with a laddered portfolio of fixed-income securities such as with individual bonds or GICs.

You can put together such a portfolio using a discount broker and, if you prefer to invest in equity funds, no-load, low-fee offerings that planners often ignore. So we see little value in wrap programs if you’re willing to do a little more work.

Mind the fees

As with any product or service you buy, financial services cost more the more you rely on other people.

Investing in mutual funds already delegates a large part of the investment process to portfolio managers. Taking advice on which funds to buy delegates even more of the process. And taking a single piece of advice in the investment business can keep reducing your return year after year.

If you invest $1,000 at seven per cent compounded annually for 20 years, you’ll end up with $3,870. But if you pay an annual two per cent in fees on that investment, you’ll end up with $2,653. Ignoring taxes, you get $1,653 for putting your money on the line. And because you paid that two-per-cent fee, you miss out on gains of $1,217 you would otherwise have made without the fee payments.

So it’s important to minimize these payments if you’re to get the most out of your investments. One way you can do this is to avoid bond funds. The median Canadian fixed-income fund, after all, charges a fee of 1.80 per cent annually. But you needn’t pay fees on the fixed-return portion of your portfolio if you buy bonds or GICs directly.